Changing places

As long-term readers here will know, I argued for quite a few years that, of the possible ways of putting a price on carbon, an emissions trading scheme was preferable to a tax (I set out my position here). But following the collapse of the Rudd government’s ETS deal with Malcolm Turnbull, and Rudd’s ultimately disastrous failure to call a double dissolution on the issue, I changed my mind.

This was partly because of changed circumstances, and partly because of a reconsideration of the politics surrounding compensation. In both cases, the driving force was the massively complicated set of free permits, exemptions and cash handouts with which the final ETS was saddled, nearly all of these going to large-scale emitters. I had seen the possibility of a limited issue of free permits as an advantage of an ETS, but now I think it was actually a weakness. And in political terms, the inordinate complexity of the CPRS made a strong case for something simple and comprehensible, where everyone understood that consumers would ultimately pay the price of carbon. Unlike with emissions permits, everyone understands that a tax on producers will be passed on (partially in the short run, and totally in the long run) to consumers, and therefore that any offsets or compensation should be directed primarily at consumers.

So, I now think a carbon tax is the best short-run option. There’s even a case, which a plan to discuss later, for leaving the tax in place when we come to introduce an emissions trading scheme, which is still the desirable outcome in the long run.

While I’ve come to support a carbon tax, John Humphreys, who formerly thought it the best (or perhaps least bad) option, is now vigorously opposing it. His change in position coincides with a change in political alignment, from the libertarian LDP to the Liberal Party, for which he was briefly an endorsed candidate last year. A few observations over the fold

First up, I don’t think being a member of a political party is a great idea for an economist who wants to comment on public policy. The shifts and turns by both parties on global warming policy illustrate the problem. In the last year, Labor has successively supported an ETS, a ‘wait-and-see’ policy, direct action like ‘cash for clunkers’ and now a carbon tax. The Libs have cycled through the same set of positions. For a party-aligned economist, the options include:
(a) loyally push the ever-changing party line, and explain away the inconsistency
(b) take a stand against the party line when you disagree
(c) interpret the party line in such a way that you can agree with it
(d) keep quiet when you disagree, and support the policy strongly when you agree
As regards carbon pricing, Andrew Leigh seems to have taken some combination of (c) and (d). John Humphrey’s early support of a carbon tax was an example of (b) since most libertarians oppose this measure (most, because they reject physical reality). But the Libs are tougher than the LDP and he has now shifted to (a).

Explaining his shift of position, Humphreys says that his support was conditional on the revenue being returned to households and businesses through cuts in other taxes. By contrast, while the current proposal does not specify a mechanism, but it’s been announced that all revenue will either be (a) returned to households (b) used to offset costs on business (c) used to reduce the costs of moving to low-emissions technology

As an economist rather than a politician, Humphreys is surely aware that it doesn’t matter much which side of the budget (revenue or expenditure) a given policy initiative affects – what matters are the effects on relative prices, incentives and the distribution of income. That’s why economists worry about things like tax expenditures and effective marginal tax rates, and why we analyse the tax-welfare system rather than treating the two separate.

Taking this approach to the carbon tax, let’s begin with households. As far as taxpayers are concerned, it makes no difference whether compensation for the effects of a carbon tax comes in the form of a lump-sum cash payment or an increase in the tax-free threshold, to take the two simplest possibilities. But one is classed as expenditure and the other as a reduction in revenue.

UpdatedThat accounts for income taxpayers, but what about those who don’t pay income tax. The answer, first put forward by Milton Friedman (someone I assume Humphries would not regard as a lefty economist) is that a combination of tax and transfer payments may be treated (analytically and for policy purposes) as being equivalent to a negative income tax for those below some threshold. In such a system, a universal cash payment is exactly equivalent to a reduction in the net tax payment. Humphries seems to have completely missed this point, both in his original post and in comments here. He persists in writing as if there is an unproblematic distinction between taxation and expenditure. This may be good politics, at least for a Liberal party member, but it’s bad economics. End update

Similarly, as regards business, the policy relevant concerns are the price of carbon and the distribution of the net tax burden. Whether compensation to business is undertaken through some form of cash allowance to firms with a large investment in carbon-intensive capital or by making some part of historic emissions tax-free makes no economic difference, it just changes the account.

Finally, there are expenditures on funding for direct action to reduce emissions. Here Humphreys has a point, except that
(a) Gillard has already cut a number of these programs on the basis that a carbon price is coming
(b) His own party is committed to achieve Labor’s emissions targets entirely through direct action. Obviously, this will require much more public expenditure than an approach based on a carbon price

As long term bloggers here will know, I have been advocating a carbon tax for a long time. I had much less faith in markets than JQ and I always argued that market systems would be gamed (both politically and financially) by vested interests.

I think a very important and basic political economy principle exists here. To put it simply, trade in goods makes market sense. However, trade in “bads” (negative externalities) does not make sense and cannot work in practice except by setting up an artificial framework to make the negative externality (or rather the amleioraton thereof) tradeable. It is the artificiality of the trade and its need for complex instruments to deal with that artificiality that leads to the excess political and financial difficulties of combating gaming and rent seeking with respect to the trade.

I would like JQ’s comments on this basic principle. To sum up;

There is a sense in which trade in goods is natural and trade in negative externalities is artificial. There is a voluntary, self-centred, short term, frequent and wide-spread desire to pay for a good. There is no such immediate, dependable, regular and widespread desire to pay for the amelioration of a negative externality particularly when it is a long term, diffuse and diffuclt to perceive (for some) risk. Given that this is the case, the free market mechanism is not the appropriate mechanism for dealing with such negative externalities. The appropriate mechanism is public policy for the public good and is best pursued by taxes, penalties and a strong public compliance system.

Would JQ be willing to consider now that the above theory provides a general principle for determining the appropriate tool (markets or public policy) for problems in this arena and that better initial appreciation of this principle would have saved government from making the initial mistake of attempting a market solution?

As a long term reader of this blog-site, I first of all would like to remind that our host, JQ, made it very clear and very early on that under certain conditions a carbon tax and a cap and trade system are equivalent.

I have expressed a preference for a carbon tax under current real world conditions, both nationally and internationally and I listed the major reasons.

I fully concur with JQ that individuals (‘consumers’ in economic terminology) are the ultimate payers of the carbon price. I’d like to add that this applies to all ‘payments’ made by ‘business’, including the payments made to management.

I’d appreciate getting Prof Quiggin’s opinion on th followig:
As for compensation payments, I don’t believe the problem is as complex as claimed in various places and by various people in the case of a carbon tax. Given that it is known that the ultimate cost is paid by ‘consumers’, a compesation issue arises only if consumers are not identical in wealth and income in an economy where ‘on average’ living standards are ‘good’ or ‘excellent’ (ie Australia, the old EU countries, Canada, some countries in Asia, South America and North Africa). This line of thought leads to the conclusion that the problem of compensating ‘consumers’ is a problem of reducing income inequality sufficiently such that the comsumption possibility of marketable goods and services of the lowest x% of people on the income distribution remains unchanged. I can’t offer a value for x, firstly because I don’t have all available data in my head or easily accessable to offer a best guess and, secondly but more importantly, this is a question which, in a democratic society, should be discussed widely.

Whether or not any ‘producer’ should be ‘compensated’ at all, depends, IMHO, on the carbon price, on recent government decisions (NSW causes some specific problems in this regard).

Using money raised from the carbon tax to subsidiese the development or further development of renewable energy technologies, is not ‘compensation’.

“But the Libs are tougher than the LDP and he has now shifted to (a).”

This is a problem with Australian politics — the value of towing the party line is too much, and so if you have some populist moron leading the party, then any people with real ideas are just going to get pushed aside, and presto, we get what we have now. Looking at Peter Garret’s situation, this obviously even includes people that one might have thought would have had at least some protection against this given his background (let alone people who don’t have such a public face like Andrew Leigh or John Humphries).

JQ – isn’t the point (b) that his own party is not actually that committed to achieving any emissions targets? As political promises go, a Coalition government will not have any problem reneging on emissions. Especially if their interventionist methods requires a lot of public expenditure and err… intervention.
Meanwhile is everyone so sure that being a Carbon Emissions pariah will not result in adverse consequences for Australia with respect to trade? I don’t see that Australia is immune from the ire of an international community that is not fooled by the “our impacts are inconsequential” line from the world’s biggest per capita emitter and No.1 coal exporter. That we are benefiting directly from making the problem worse via our fossil fuel exports whilst taking no responsibility might be fact that many Australians will, out of self-interest, overlook, we can be sure the rest of the world is not going to be fooled.

I think the strongest argument for a tax is that noone really cares about emission flows. Its stocks of emissions in the atmosphere that matter. Setting a price and getting it wrong in terms of emission flows does not matter much. Setting rates of emissions as annual carbon release quotas therefore offers few rewards and involves potentially unstable prices.

If you want an ETS I strongly favor backing it with a tax as well that sets a minimum price on emissions – the sort of proposal put forward by Peter Wood and others. This helps establish policy credibility for electricity utilities since they know carbon prices will not collapse towards zero leaving them locking in on unprofitable assets. The worst that can happen is that the ETS price goes to zero – firms still must pay a carbon tax.

That observation is true only secondarily and dependently. It must be remembered that the market will only address the situation after primary market failure is addressed by democratic legislative action. It is clear that we are faced with an issue of MARKET FAILURE in relation to dealing with the negative externality. The free market unaided FAILED to address the problem. The argument was then over using democratically legislated method A or method B to address market failure.

Method A was a complex and artificial scheme to render the amelioration of the negative externality tradeable. This system was likely to be difficult to formulate and economically “gameable” in every formulation. The attraction of method A (I presume) was that some parties thought they could game it and other parties thought it a good way to for the government to appear hands off, avoid direct responsibility for outcomes and criticism for another tax.)

Method B is a straight forward scheme to tax the negative externality and simplify the compliance measures. As usual in our system (democracy subverted by corporate influence) the straightforward, logical, equitable and effective way to handle this issue was avoided as long as possible.

a good while ago(i’ll hunt it out and post the date early in the coming week.)
New Scientist did an article on the cost of amelioration of climate effects broken down by item.
how much more for petrol, electricity ,food,etc in the UK.
the cost was risible.

It appears that one of the bugbears of the ETS, namely carbon credits or offsets, will be revived as carbon tax deductions for large emitters. This follows both from the NZ carbon tax approach to forestry and Garnaut’s recent report that favours ‘carbon farming’. Noting that the European ETS regards such carbon sinks as temporary it would also seem to create the moral hazard of exaggeration. In our eagerness to avoid burning less coal we will assess the carbon sinks too highly. Ideally we need reverse credits in case the carbon sink succumbs to drought, disease or fire.

A way or minimising the rebound effect of tax cuts or pension increases would be to allow only a limited range of accredited forms of spending. For example the householder could get solar hot water, double glazing or smart appliances based on their estimated carbon tax burden. That way they can’t spend the tax cut on either grog or simply paying more for the same amount of electricity. However we’ve already been down that path to some extent with roof insulation and it didn’t go well though perhaps we could use better trained installers.

I completely concur with your paragraph 1 @8 but not with your paragraph 3. An administered price (tax) mechanism is also corruptable by special interests such as corporate interests.

(If the world would be approximately equally developed in terms of technology and wealth or income distribution and if ghg emissions would be the only instance of market failure and if the introduction of a cap and trade scheme would intertemporily complete the market then a cap and trade mechanism would be my preferred mechanism.)

“it makes no difference whether compensation for the effects of a carbon tax comes in the form of a lump-sum cash payment or an increase in the tax-free threshold”

I don’t think is correct. One reason why you may prefer an increase in the tax free threshold to a lump sum payment is that an increase in the tax free threshold doesn’t provide a disincentive to work while a lump sum payment does. The choice of lump sum payment vs increased thresholds might not matter to households but this choice has noticably different impacts on incentives.

I wrote this back in November last year, but I still regard this scheme (with some tweaking modifications on household compensation) as the best interim framework for pricing CO2 emissions:

|||
For quite some time I’ve thought the best interim measure for pricing carbon would be an adjustment to the tax treatment of goods and services entailing the combustion of hydrocarbons.

We simply set a “dirty energy benchmark” based on bog standard coal combustion (for stationary energy) and bog standard petrodiesel or petrol combustion (for liquid fuels). Deductibility would be pro-rata the benchmark. Anything above the benchmark would incur a penalty rate of tax. The price would then be passed on in all goods and services. Diesel & LPG fuel rebate would be abolished.

We could set aside pro-rata rebates for those on or below AFTWE in cash or means-tested kind (public services that would normally be non-discretionary, such as housing, education, medical and dental, perhaps a staple food and grocery concession card).

At the same time we could use perhaps 25% of recovered funds to tender for replacement of the oldest stationary plants with plants meeting much stiffer constraints — perhaps 5-40% of the current footprint with equal availability. We could offer soft loans or other incentives to those able to meet the performance standards after passing due diligence.

The retooling this would set in train would weaken resistance to a CO2 price and make it possible for any cap and trade system to be a lot more aggressive since some of the upgrades would have involved radical redesign of business processes to lower C02 intensity to as near to zero as possible.

Ernestine wrote “An administered price (tax) mechanism is also corruptable by special interests such as corporate interests.”

This is true to an extent but I would add that a tax mechanism in a democracy is less corruptable in principle and practice. This is so because it has relative simplicity, transparency and more direct responsiveness to the democratic will in its favour.

Complication, obfuscation and removal from direct democratic control are ever the methods of corporatism. If we, the ordinary people, play the game on their rigged playing field we get exploited much more.

@Tom Davies
And unless you value the time spent going through various government bureaucracies applying for your payment. Why not just cut the GST rate as you increase the carbon tax rate, as was suggested here previously? They’re both regressive taxes. It would have minimal effect on equity.

@Christopher Dobbie
Combet has also apparently reassured coal mining companies and unions there will be no job losses. So either serious disconnect with reality or maybe just lying to those of us who want climate change action – but we just haven’t yet found the loophole in the detail yet.

1. is meant to replace other sales taxes
2. is designed to underpin state (as opposed to Commonwealth) revenue and the swap would have to come at the expense of household and other rebates or state revenue or the commonwealth balance sheet
3. does not take any account of CO2e intensity and thus leaves industrial scale externalities untouched. The biospheric industrial sewer is just as cheap an option to explout as it is now — and indeed, in relative terms, it may be cheaper.

The GST and other consumption taxes are in most cases regressive taxes and have contributed another layer of support to the now evident problem of an insidiously slow but inexorable rise in inequality (we can add the penchant amongst some for user pays charges on existing infrastructure built with prior generations taxes to the inequality problem).

I dont like the addition of another regressive tax (and why should it be designed to be regressive??? Progressivity in the tax system is urgently needed), else why not just double the GST and allocate half to carbon – semantics. What we argue for is yet another hammer to bludgeon the poor with? Im all for a carbon tax but Im not for bludgeoning the poor and middle and adding to inequality further. The large mining firms have been let off the hook more lightly after an immoral and unethical media campaign. Clear objection from me on that one – especially when the miners also manage to repatriate a lot of the profits from their warming activities offshore as well.

There is another side to the issue of blaming corporate capitalism for greenhouse emissions (or anything else). This is the issue of our own responsibility for letting the corporates dominate our society, our own complicity in living the lifestyles facilitated by corporate products. When Americans were bitterly blaming Shell for the Gulf Of Mexico oilspill disaster, they often spouted this blame whilst standing amongst large SUVs in shopping malls with enormous carparks. Seen in this light, all of us are clearly to blame.

Philosophically speaking, I think the Deep Green movement’s overall viewpoint is correct. However, I don’t accept their activist agenda of dismantling and sabotage. The activist agenda is morally dubious and in any case unnecessary as late stage capitalism will destroy itself (and most of us) without any active Deep Green agenda.

“The Deep Green movement believes that civilization, and especially industrial civilization, is fundamentally unsustainable and must be actively dismantled in order to secure a livable future for all species on the planet.[1]. It is based largely on the concept of Deep ecology, which recognizes the inherent worth of other life forms and features of the natural world aside from their human utility.

The movement differentiates itself from “Bright green environmentalism”, characterized by a focus on personal, technological, or government/corporate solutions, in that it holds these solutions as inadequate.

The Deep Green perspective argues that the dominant culture, a term that encompasses all societies that are based on industrialism, will not undergo a voluntary transformation to a sustainable way of living. This includes the dismissal of a possible success of a slow and soft shift to sustainability. Individuals in the Deep Green movement believe that industrial civilization must be forced into collapse in order to maintain as much of the living world as possible, noting that carrying capacity is further diminished as civilization continues. The Deep Green Resistance supports an active resistance movement with the objective of accelerating the collapse of industrial civilization.[1] – Wikipedia

My point of view is that I would support a peaceful, passive resistence to corporate capitalism. There is no need for activism as this system will very effectively destroy itself. For example, the armaments industry and all the wars it facilitates are most effectively accelerating the end of industrial society.

Irony Alert starts! In fact, are all the top corporate CEOs actually Deep Green operatives destroying industrial civilization in the most effective way possible? Irony Alert ends!

@Fran Barlow
I don’t understand these objections.
Point 1 seems not to be an objection at all.
Point 2 seems to be concerned with the balance between state and federal government revenue since the states currently collect the GST. But this shouldn’t be a problem; if total government revenue is unaffected (because carbon tax revenues meet the GST shortfall), then just have the fed guarantee that state revenues will be the same. Who could object to that?
Is Point 3 agreeing with me? Yes, the GST taxes every final consumption good equally, regardless of CO2 emissions intensity. We don’t want that, we want to discriminate against dirty industry. So let’s reduce the GST rate, and increase (from zero) the carbon tax rate.@Alice
I’m not saying we make the tax system more regressive. I’m saying reduce the rate of one regressive tax, and introduce a new one, thus leaving the overall amount of regressivity unchanged. If you want to reduce overall regressivity, then by all means, reduce the GST even further and take up that slack with an increase in progressive income tax. I could be in favour of that, but it’s a separate issue to what’s being discussed here.

{the G&ST is meant to replace other sales taxes} seems not to be an objection at all.

The implication is that you can’t reduce it by the quantum of the impost of the fixed price on carbon unless you hand back all of the revenue so raised to the states, but that in turn makes it impossible to refund households for price imposts assocated with the carbon price. The G&ST is levied on goods that are not the same basket of goods as those consumed by low income CO2-intensive households. Reduction of G&ST on a $60k landrover doesn’t help a low income household heating their water with gas.

Point 2 seems to be concerned with the balance between state and federal government revenue since the states currently collect the GST. But this shouldn’t be a problem; if total government revenue is unaffected (because carbon tax revenues meet the GST shortfall), then just have the fed guarantee that state revenues will be the same. Who could object to that?

Someone who wants to compensate low income households? (see above)

Yes, the GST taxes every final consumption good equally, regardless of CO2 emissions intensity. We don’t want that, we want to discriminate against dirty industry. So let’s reduce the GST rate, and increase (from zero) the carbon tax rate.

Ok … my apologies for the last one … I had a paragraph in a “scraps” word file and copied and pasted something intended for someone else carelessly. These days, I’m used to things failing to go through and I use this as a device for ensuring I don’t lose text.

I still regard my scheme above as simpler. You’d require very little new legislation (perhaps defining the benchmark and the penalty rate). There would be no loopholes. Businesses that wanted B-A-U would not have to fill out any new forms. Indeed, they could save themselves the trouble of accounting for their fuel bills. You could introduce the scheme this July rather than next. It could not be called a GBNT.

One they were paying for energy out of after tax income, the temptation for energy to get back into the before tax income column would be considerable.

@sam
I could be agreeing with you on that one Sam (lower the GST, replace with a carbon tax) and then go looking to getting some of the GST shortfall back from those who use Lichtenstein as a holiday home – I mean we talk about a small tax change here for something beneficial and every newspaper in town is squealing like stuck pigs but did they squeal (not even a peep) when corporates and higher income earners were the beneficiaries of enormous tax cuts relatively in the 1980s and 90s??
Tax cuts good tax rises bad (its become an Orwellian chant from the subversive conservatives).
With the exception of flat regressive taxes we all share so the rich dont feel so squeemish about compensating poor households.

Fran Barlow :
The G&ST is levied on goods that are not the same basket of goods as those consumed by low income CO2-intensive households.

Ok, so here you’re saying that a low income household is on average more carbon intensive (per dollar of consumption), than a high income one, so a straight substitution of sales tax for carbon would hurt the average poor household on balance. That’s interesting, it certainly could be true, is there any way to quantify this effect?

what a supposition from Fran – “low income” and “carbon intensive” households as if it goes without saying. Of course…why wouldnt I think so too?
Well Ive heard low income households turn off the electricity more because of the bills Fran plus they own fewer gadgets and have fewer rooms…Then there is the CO2 of the absolute value of a households consumption released. Why not compare that?
Why would you measure CO2 as a percentage of consumption over income brackets of households without taking the simple necessities of life into account?, when the car use by a low income household is likely to be for essential travel whilst the high income family breadwinner/s is/are likely to be using jet fuel more often even if they leave the SUV at home because they can afford the luxury of living one red light from the city?
A shallow measure it seems to me with a some pretty crude and broad assumptions behind it but I guess we know that low income earners are responsible for all sorts of things but first Ive heard they can be now blamed for global warming as well.

AIUI ACOSS (and IIRC the Brotherhood of St Lawrence) did some work a while back on this and established that the basket of goods meant that a greater proportion of household income was on goods and services that would be negatively impacted by a carbon price.

It would probably be that the total spend of high income houszeholds would be greater but then they have more income and more of that is discretionary and also, they’d more likely benefit from G&ST reductions too.

@Fran Barlow
says “It would probably be that the total spend of high income houszeholds would be greater” and given there is so much CO2 in that total spend, taking into account current production methods, the total CO2 footprint of hgher income households is larger than low income households Fran.
Reality check needed before you link the words low income households and carbon intensive in one sentence again .

Very cheeky JQ. I have always been very clear about my position — that any carbon tax needs to be revenue neutral. This point was the very reason that I wrote my original paper back in 2007. So I think it a bit unfair to say that sticking by my point is an example of changing my opinion. My position now is EXACTLY what it was in 2007.

As an economist (and not a politician) I know that taxes create a deadweight loss, which is not a transfer between economic agents, but a net loss to the economy. Consequently, a cut in tax reduces deadweight loss and provides an opportunity for increased allocative efficiency in the economy. It also increases individual control over their own economic activity, thereby increasing “freedom” and personal responsibility (leading, hopefully, to more responsible behaviour). It also reduces the barriers to trade, and in my opinion it is trade (not government investment in R&D) that is the primary driver of economic growth. For more on this, consider the literature on the “dynamic efficiency” gains from international trade.

In contrast, extra government spending does not reduce deadwight loss. It is theoretically possible that government spending could provide a benefit that exceeds the costs of taxation… which is presumably why social democrats endorse high-tax and high-spending policies. However (as you would know) I am quite skeptical about the benefits of government spending, and it is my opinion that government spending is often ineffective and sometimes counter-productive.

Given my views on tax and spending, I think it is very reasonable for me to draw a clear distinction between lower tax and higher spending. Indeed… given that I have been an outspoken libertarian for over 10 years, I think most people would be thoroughly unsurprised by my position. And whether you agree or disagree, I don’t think you can fairly say that my preference for lower tax is a “change of position”.

P.S. I have never endorsed the Liberal Party policy of direct climate action, except to say that at least it is cheaper than the Labor policy. So given your four options for economist-politicians, I think I best fit into (d).

The term ‘carbon tax’ is unfortunate even though it is an unambiguously well defined term in the context of Lindahl’s work on the optimal taxation for the provision of a public good. The public good in question consists of a reduction in ghg emissions.

Unfortunately, the term ‘carbon tax’ facilitates the confusion of ariving at an (administrative) price for ghg emissions, aimed at changing relative prices of marketable commodities, with an increase in taxation per se.

IMHO, a carbon tax cannot be strictly ‘budget neutral’ because the design and implementation of a carbon tax mechanism to solve a market failure problem (ghg emissions are a negative externality) requires additional government expenditure. To argue for a strictly ‘budget neutral’ carbon tax (eg reduce other taxation by an equal amount) is an argument for a general reduction in taxation. To illustrate, 100 years ago there was no Minister for Climate Change anywhere. Now this is an important portfolio just about everywhere.

While I have sympathy with jakerman’s point, I cannot see how the link shows there is no deadweight loss.

“Taught-economics 101” produces what it calls a deadweight loss from standard diagrams representing “supply” and “demand”.

However the real reason we do not have to worry about deadweight loss is not easy to see.

Obviously there is no deadweight loss if supply is perfectly inelastic.

But more to the point, deadweight loss is not a economic loss.

If the revenue square (price times quantity) before the change, is the same as the area of the new revenue square after a change (ie new higher price, times new lower quantity), then the same value flows through this market.

The people who lose are those with the weakest demand, but they retain the cash they had, and are free to purchase substitutes. They do NOT lose the area “Taught economics 101” trains graduates to baulk at – the standard deadweight loss triangle.

But the new tax (times the new quantity) creates revenue and, in usual circumstances, this area is greater than the deadweight-loss triangle – particularly for inelastic supply curves.

Deadweight loss is really a loss of utility for some, but this can be compensated for. The real loss is only some consumers surplus (not really an economic loss – just utility) from those who had higher demand, presumably because they were richer to start with.

However these purchasers have to pay a higher price (tax revenue) and this maybe withdrawn from other markets.

This all balances out – the circular flow still operates and there is no net loss to the economy.

If supply is not inelastic, some previous suppliers now refuse to supply – so public provision, funded by tax revenue becomes attractive.

Anyone interested in this should read pg 300-301 of Hal R Varian “Intermediate Microeconomics: A Modern Approach” for a typical rendition of this archaic theory.

“Efficiency” and “freedom” are similar “taught-economics 101” concepts. They also have weak application to real life and little analytical value.

“Consequently, a cut in tax reduces deadweight loss and provides an opportunity for increased allocative efficiency in the economy.”

Your argument holds in the theoretical world of an Arrow-Debreu model. However, in this theoretical model the argument is artificial because there is no room for a government (or any other form of organisation with managers of any type). But this is not the world we live in. This is not a criticism of the Arrow-Debreu model as a piece of thorough theoretical research but rather a plea to study it.

@jakerman — the article has a number of problems. First, it was “federal” instead of “total” size of government. Second, there is observational equivalence with the public choice theory that wealth leads to big government (not big govt leading to wealth). The old “correlation-causation” trick. Third, the data provided had no lag. Forth, the graphs are unable to control for other contributing variables. Fifth, the data was just for one country, while international data shows that more economically liberal countries generally have a better economic performance.

Also, the fact that a country can have growth with high tax does not disprove the existence of deadweight loss. It exists by definition so long as the elasticity of demand is not perfectly elastic. This is not open to dispute, as it is an identity. The reason that some people still support a high-tax and high-spending scenario is that they believe that the government spending has enough benefits to compensate for the costs of the tax. Perhaps, but that is a separate debate.

@Chris Warren — DWL is the excess of the reduction in producer surplus (CS) & consumer surplus (PS) over the tax revenue gained. So long as demand is not perfectly inelastic (and it isn’t) then DWL > 0 because there is no revenue to compensate for the lost CS & PS caused by a reduction in quantity. Note that the utility loss from not being able to make a preferred purchase is just as much an “economic cost” as any financial cost. Economics isn’t about money.

@Ernestine Gross — The existence of DWL exists in any theoretical or real world where demand is not perfectly inelastic.

(I note that the above discussion is only regarding the allocative efficiency gains from tax cuts, and I repeat that there are other potential benefits. I think one of the most important but under-appreciated is the dynamic efficiency gains, as evidenced by the literature on international trade.)

===================

But all of this is a beside the point I want to make. I have not changed my position. I used to believe in small government and low tax. I continue to believe in small government and low tax. To describe my consistency of views as a “change of position” and imply that I’m a partisan hack is grossly unfair.

A more honest complaint about my position is that it is boringly consistent. The idea that a libertarian would oppose a policy that increased total tax & spending should not have surprised JQ at all. The idea that I would want offsetting tax cuts is the most obvious thing in the world.

Thank you for your reply. I believe the topic is too important to just leave it at that. In my posts @35 and 36 I tried (again) to say in non-technical language why the term ‘carbon tax’ is likely to get people to think about a different problem to what it actually is meant to solve. I was hoping it is common knowledge that politicians, their staff, people in various private and public agencies, like employees or contractors for private business, don’t work for free with the implication that any policy design and implementation requires real resources. Your argument for revenue neutrality is, strictly, an argument for a general tax reduction and hence expenditure reduction, assuming a balanced budget is the aim. I still maintain this is the case.

Now to your reply to my post @40

“The existence of DWL exists in any theoretical or real world where demand is not perfectly inelastic.”

(There seems to be one superfluous ‘exist’; the word ‘existence’ also has a different meaning in theoretical work from that in empirical; but this is merely a point of clarification.)

A perfectly inelastic demand, as represented in some introductory economic textsbooks, is a theoretical impossibility in any model of a ‘real’ economy which has a finite life (possibly very long in terms of years or decades or centuries), such as the Arrow-Debreu model, and hence finte resources. But this does not establish that your statement is true. Given the welfare criteria in the Arrow-Debreu model, the assumptions of the model provide sufficient conditions for the solution of the model to satisfy the welfare criterion. Since this model is a model of a competitive private ownership economy with complete commodity markets and no externalities (‘free disposal’), introducing an agent, called government, characterised by taxing and spending, amounts to introducing a superfluous agent such that the optimality of the solution is destroyed. But ghg emissions are a negative externality!

Please provide a reference to support your statement from the theoretical literature on incomplete markets.

Please prove that there is a DWL in a Lindahl equilibrium.

Or,
Please provide a reference to a theoretical model of a competitive private ownership economy which has negative prices in its solution.

@Chris Warren — DWL is the excess of the reduction in producer surplus (CS) & consumer surplus (PS) over the tax revenue gained. So long as demand is not perfectly inelastic (and it isn’t) then DWL > 0

As I said it is not an economic loss, as understood in similar terms as “economic profits”. As you no doubt realised, I was talking about the economic activity involved in a market activity.

There is always a loss to a market if tax revenue is extracted. This reappears in some other market and these participants receive gains.

The same applies to forgone CS and PS. When tax revenues hit an alternative market, an additional quantity is puchased and a more preferable outcome is achieved as three variables (price supply schedule, demand schedule) change beneficially.

But also the amount of available CS and PS must increase (as curves move to the right – away from the origin). This new PS and CS counters any DW loss to society.

When most people talk about economic; losses, costs, rates of return, and profits – they are not adding and subtracting consumer surplus or producers surplus. You do not determine the present value of an asset, by summing a stream of producer or consumer surpluses. It is not relevant to say:

Economics isn’t about money.

When people receive wages and pay their rent and buy food, they can only spend their money, and their demand is entirely fixed by their money. You cannot lodge a wage claim for a $10 payrise plus 10 units of surplus. The concepts cannot be mixed.

IN any case, when anything changes, some markets will always loose revenue and surplus, but this must reappear elsewhere.

Most people assume that the proposed tax is a loss in carbon-using markets but realise this produces gains in preferable markets.

In other words, the tax leads to useful contraction in the bad carbon-industry and funds useful expansion in better sustainable industries.

@Ernestine Gross — the demand in question is the demand for whatever is being taxed. If you are taxing shoes, then there will be a deadweight loss to that tax so long as the demand for shoes is not perfectly inelastic. You don’t need a GE model to show the existence of DWL.

You touch on the point where this discussion does get quite a bit more complex, the instance where a tax results in more optimal allocation of resources by internalising an otherwise external cost. However, that is problematic with climate change for two reasons.

First, the “environmental benefits” are generally counted separately, and refer to the same change in behaviour. If we count that benefit here (by not counting the welfare costs to the consumer & producer) then we would be double-counting. This is a problem with the so-called “triple bottom line” accounting. Any good economic analysis already included environmental and social issues… so if we are going to count them separately we need to ensure that we are taking them out of the “economic” number.

And secondly, climate is a bit of a unique situation because the ultimate solution to the externality rests solely on the supply side. Consequently, any change for the consumer away from their utility-maximising choice set would be a social utility-loss (unless it was directly linked to improved supply-side behaviour).

Irrespective of all this (and sorry to harp on) the point I want to make clear is that I have always argued for the need to have offsetting tax cuts. As a libertarian, I think that most people would find that insistence to be quite normal. Suggesting that sticking to my same position represents a “change of position” is quite unfair.

I didn’t come here to insist I was right. Just to insist that I have been consistent.

(I note that keeping tax revenue the same is NOT a tax revenue reduction. It is, by definition, keeping tax revenue the same. You are right that the governments new scheme may cost resources. I don’t care. I will not support a scheme that increases total government tax & spending. If having a carbon tax is really the “greatest moral challenge” of our day, then surely the advocates could put up with a reduction to other taxes & spending.)

John Humphreys sure the data is not perfect, since when do economist have perfect data? But your claims that “a net loss to the economy” suffers from more more problems than you attribute to this data. What data do you base your black and white certainty on?

A convincing piece about John Humphrey’s approach (preferred him with the LDP) and a convincing piece by Prof. Quiggin about why a carbon tax is preferable (admittedly my position all along) and found the CIS piece on a Carbon Tax supportive and convincing of my view pretty much for the reasons the boss gives above.
From what I can tell though, Prime Minister Gillard is not proposing a Carbon Tax as described above (and recommended by Garnaut) but the ETS with a price on Carbon that acts temporarily like a Tax until the ETS comes in to full swing. This is no different to the mechanism that Former Prime Minister Kevin Rudd announced.

@Chris Warren — I’m not sure what you mean by “economic loss”. In economics, welfare is measured by the consumer & producer surplus. For consumers, their surplus is not money, but the difference between the utility they get from the purchase vis-a-vis the utility they otherwise have from the money (which will be lower by definition, or they wouldn’t make the trade).

When you write “economic benefit” I think you may be referring to “accounting profit”. The concepts are quite different.

The tax revenue is not considered an “economic loss” as it is simply a transfer. Whether it results in a loss or a gain depends on the efficiency of the government spending, which is a different issue. The welfare loss considered by economists when we say DWL is the lost consumer & producer surplus due to the reduction in quantity traded.

You are right that money is important to people. However, it is not what drives people in economic models. In economics, we assume that the driving motivation is “utility maximisation” and that the goal of human behaviour is (to put it crudely) to be happy.

If you could buy a $10 dinner that tasted great, or a $10 dinner that tasted horrible, they are not equal. Yes, they cost an equal amount; but they did not bring you an equal amount of utility. In economics, what we are concerned with is the utility, not the income.

You appear to have fallen for the “zero-sum game” fallacy. Trade is a positive sum game, and so restrictions on trade (including taxes) are a negative sum game. You are right that a carbon tax will hurt some industries and help others, but when economists talk about the impact of a carbon tax, they are counting both the winners and the losers and working out the net impact. As Treasury showed (using quite optimistic assumptions about a global treaty) the *net* impact of a carbon price is likely to be a reduction of GDP of about 5% by 2050. That is *after* you factor in all the so-called “green jobs”.

As I said, economic loss is understood in similar terms as economic profit. This seems clear enough, but if you need a quick lesson.

When price is above average total costs – economic profits exist. And in exactly similar terms:

When price is below average total costs – economic losses exist.

This is very, very basic. NB – you do not add-in consumerproducer surplus.

IN fact they are so similar – you can call losses “negative profits”, and presumably, profits can be viewed as “negative losses” if anyone actually does this.

So clearly, this has nothing to do with consumer surplus or producer surplus. As this was so clear for anyone who knows what economic profit is, I was a bit bemused by your query.

Similarly, your leap into ‘accounting profits’ is odd. Economic benefit is not this. I do not think you have got an appropriate control of your concepts.

As I said originally, so-called deadweight losses are not economic losses (properly understood).

Noone has said that motivation is not utility maximisation, but again this is just jumping all over the place. Once a tax is in place against a bad industry, the released funds reoccur in some other market where additional consumer and producer surplus may become available, countering any so-called deadweight loss.

The net result can easily be “utility maximising”. So I do not see any real issue here.

Unfortuately you are not making mush sense over “zero-sum game” fallacy. Again you are jumping all over the place.

Treasury is not able to predict any economic variable in the Australian economy further than 2 quarters out, and never has, except by chance.

A carbon tax may reduce GDP by some %. However by protecting the environment this cost actually purchases huge benefits for Australians.

I do not baulk at reducing GDP for a better world. This just means that people get a huge boost in lifestyle than other-wise, even those who were never able to generate demand on the economists chart or ever figure in GDP calculations.

John Humphreys, given your association with groups such as Menzies House that appear to consider climate science to be Bad Science – not simply wrong but as some kind of weapon of the Green Left that’s intended to do harm – and that consistently opposes every serious proposed policy measure to reduce emissions whilst failing to offer credible alternatives, you need to do a lot more to convince me that your arguments are something more than more of the same.

I think it’s safe to assume that, in the case of emissions, we will not see an overall willingness for everyone to take personal responsibility and go on to freely engage in more responsible behaviour especially when groups like Menzies House are intent on promoting doubt and denial in order to induce delay. It’s clear the Right absolutely do not want business, government, or the community at large to take responsibility; on the contrary they oppose the existence of the problem in order to justify an absence of responsibility.

The Right needs to accept the existence of the problem and start coming up with credible alternative policies that are aimed at the problem rather than preventing action.

The artificial Left/Right divide on this, and most of all on the existence and seriousness of the problem, has to end.

Ken – the right has offered a solution. It’s called nuclear power. It was invented by scientists. John Quiggin has banned discussions of nuclear power so I won’t bother trying to discuss it here.

All the behavioral evidence suggests to me that in the hands of the green left climate science is being used as a destructive weapon. I have mixed feeling about whether this is intentional but either way it is destructive and they need to be stopped. It would be nice if we could do this politely over a cup of tea but I no longer have much faith in that strategy. I think it will come down to irrational fear wars which is regretable. I’m predicting not advocating.

Terje, the Right in Australia has not seriously proposed nuclear as a solution. It has not proposed any sincere policy response. Nuclear has primarily been used as a wedge, to exacerbate divisions amongst those most concerned and committed about emissions and climate and to try and damage The Greens’ credibility amongst such people. If the Coalition has sufficient acceptance of the seriousness of the problem to propose serious policies, nuclear or otherwise, it’s news to me.

The Coalition – the Right of Australian politics – is not betting it’s electoral chances on promoting a low emissions nuclear future for Australia, it’s betting it’s electoral chances on Australian’s being so apathetic – or antithetic – to the climate change issue that simply opposing climate policies of others will get them over the line. They actively choose to encouraged their constituents to be ill informed and antithetic and I think that’s dangerously irresponsible.

Menzies House, which Humphrey’s is part of, is complicit in encouraging ignorance and misunderstandings about the nature and seriousness of the issue. They are devoted to undermining efforts on this issue, not to putting forward solutions that they are prepared to fight for.

This meme that climate science is being wielded by the green left as some kind of “holy hand grenade” is simply perverse indeed, @Fran Barlow

I wouldn’t characterise myself as green left (I know nothing of Marx, and, I do like nature so very much I couldn’t live without it 😛 ), although some others would incorrectly see me that way. Nevertheless, I cannot imagine very many people even from the green left (whatever that is, I’m guessing that Terje is using it broadly, not narrowly) wanting to destroy civilisation as the opposition to some kind of global action would have it portrayed.

Sure, some people may wish to see population to peak and reduce somewhat over time, or at the very least to have a smaller impact upon the natural environment over time. Only an anarchist would be not unhappy with the destruction of civilisation. Anyway, even the expression “destruction of civilisation” greatly exaggerates what can be expected from the most extreme outcomes from either business-as-usual for GHG emissions, or from the most extreme reductions in GHG emissions possible across the human world. It might get ugly for awhile but there will be civilisation for the remaining humans because that’s what humans do. If civilisation shifts to take a slightly different path to the future from the one that denialists demand, what is the big deal; why do they lie and create bizarre fictitious realities in which eco-fascists + commies bring down the democratic world via the Trojan Horse of Anthropogenic Global Warming (aka AGW)? Afterall, the asymmetry in the issue is substantial, in that the consequences of choosing to act like there is no AGW and then copping the average case or worse if it turns out to be true, are far more severe than the converse case of assuming AGW is true and making changes to our energy production that turn out to be not required if AGW is actually false. Some of the changes to energy systems are probably desirable on other environmental and even economic grounds, anyway. We’ll eventually see.

Terje, the failures of mainstream politics to address this and other sustainability and environmental issues is the reason for the growing popularity of The Greens. Those concerns have a strong foundation in science and mainstream politics has not responded decisively. That the Greens and green left come with baggage and blind spots is hardly unique in Australian politics. That they will be politically opportunistic and try and link the issues that they are trying to advance is also not unique, but they are a minority in representative terms and ultimately mainstream politics makes or breaks these policies.

The response of mainstream politics – mostly, but not only from the Right – to portray the Greens as destructive is a popular meme that has some resonance amongst those who see little value in ecological protection and don’t want their short term activities limited for the sake of long term environmental protection. But it’s being used divisively and destructively by the Right, in order to prevent action on these issues as well as to avoid facing those issues squarely themselves.

The Right could have chosen to take the threat of climate change to our future seriously and fight for policies like nuclear to reduce it’s impact but chose instead to protect the fossil fuel interests and to vilify the loudest voices for it being on the political agenda at all.

may :a good while ago(i’ll hunt it out and post the date early in the coming week.)New Scientist did an article on the cost of amelioration of climate effects broken down by item.how much more for petrol, electricity ,food,etc in the UK.the cost was risible.
any chance of seeing something like that for here?

@TerjeP
What an absolute porker Terje P and you know it – you were in here not so long ago accusing JQ of banning discussion of climate change (after having your probably close to 100 posts) and now you are doing the same thing – accusing JQ of shutting down disscussion on nuclear power. Spare me. Go back to ALS and stay there – you are a nuisance.

The Profs discussion pages on pro vs anto nuclear including comments ran to in excess of 500 posts. See much else that reaches those numbers Terje?

Go complain you are being shut down when they throw you in Guantamo or some other incxarcertion facility of ill repute. Youwouldnt know freedom of speech if you fell over it obviously.

JQ closed it (nuclear winter discussions) after 500 plus posts because – it had got boring.
That simple. Over it. No one shut down at all – just plain exhausted ie heard it all before… and bored.

To assert that all taxes are a “dead weight” on the economy is quite incorrect. It depends entirely on how the money is used. The taxes that built the Sydney Harbour Bridge, for instance, can hardly have been called a dead weight. Taxes that fought wars certainly were, but taxes that built NSW power stations were not. Taxes that build are not dead weights because they multiply economic performance , and usually at a time and in a manner that private industry is not capable of performing or achieving.

Global Warming Abatement is just such an instance and need. The damage is entirely created and exacerbated by private enterprise which has not found a need or manner to self regulate excesses. Only a concerted government response can turn this situation around. John Hunmphries should know this if he is anything of an economist worthy of contribution.

Carbon Pricing is an instrument intended to apply, finally, a brake on environmental degradation. Its cost is only a small contribution to repaying the cost of this environmental degradation which is caused by our combined economic activity, a cost externalised from our economic balance sheets up till now. We have been living a lie. We have shut our eyes to the damage to the environment that our community causes. But now that damage has started to undo our achievements and could very well destroy most of what we take for granted as being “permanent”. It is time for our economies to pay up.

So the question becomes “is the cost of stabalising our Climate and protecting our resources a dead weight on the economy?”

I’m still not that confident the Carbon Tax will get up and not entirely convinced that Labor would be upset if it fails. Especially if they can point the finger of blame elsewhere than their own failings. To my mind they aren’t selling it very well – but that could be the result of seeing things through the murky coloured lens of mainstream media. Interesting to see how PM Gillard plays it after her meetings with the US President and that even more powerful and influential personage, Rupert Murdoch.

@Ken Fabos
Broadly agree with you, that Labor may not be that upset if the CT dies. However, Gillard will be taking the CT to a different senate after June 30th this year, one that doesn’t provide the Liberal/National Party coalition with control of the senate. She (obviously, of course) knows this.

Personally, I hope to live long enough to find out why Rudd pulled the plug on the ETS after the Turnbull overthrow by Senator Nick Minchin and his band of merry Munchkins. The Labor government had held their ground well – bribes to industry and PR firms aside – and could have certainly have blamed the Liberal/Nationals coalition for not passing the ETS during the composition of the senate at the time. The Labor party could have argued for demonstrating patience and taking the ETS to the next election, the one that Gillard won – but nearly lost – without an ETS or Carbon Tax. The Labor support in that recent election simply moved to those who still supported action on CO2 emissions – the Greens; the irony is that that gave Labor a a final coalition with which to form government, something they may have been able to do in their own right, if they had kept the ETS legislation as a commitment to take to election. Anyway, it will be interesting to hear the views of the major players in the change of PM during the quite successful term by the original PM. Once upon a time the ABC could have been trusted to make an accurate and fair account (whether Labor or Liberal/Nationals were the subject matter); now, it is much harder to see who could do a reasonable account of Labor’s power players during that period.